When it comes to choosing a PE partner there are several factors which you should consider as a business owner/CEO. The most important factor really depends on your personal circumstances, but I have listed the main areas for consideration below.
PE firms with extensive through the cycle experience can share a perspective to allow you to see around corners. They may not be right 100% of the time but having had a previous experience, can shed light on what may happen as they have seen similar situations unfold before. This often manifests itself in having an appreciation for more radical outcomes both on the upside and the downside. In the absence of that experience investors tend to think more incrementally. We saw the benefit of this collective experience in dealing with C-19. We recognised early that this could have a more dramatic effect on business models and encouraged our investees to imagine more extreme scenarios (50%+ changes to revenue) which ultimately did happen. This maturity allows these PE firms to not get too excitable about day-to-day trading outcomes but be more focused on longer term value drivers.
Many entrepreneurs think that the primary reason for bringing a PE partner on board is to access a specific talent network to accelerate the growth profile of their own business. PE firms often recycle talent from previous successful situations they have been involved in. The best PE firms are talent magnets and will be able to attract quality executives and non-executives even if they have not had specific experience in a particular industry vertical.
3 Geographic reach
If businesses are looking to enter a new market or accelerate their growth, they should look to partner with a PE firm with a presence/experience in that location. It is possible, but it is hard to make meaningful headway remotely. PE firms with in-market experience will mean that you can avoid “learning as you go”. At Livingbridge we have teams on the ground in Europe, North America and APAC.
4 Corporate strategy
Creating a sense of alignment before an investment is critical. You should look to co-create a business plan (which typically covers a 4-5 year period) with your equity partner before consummating a transaction. You do not want to work out post-deal that there was some misunderstanding or misalignment on strategic direction. PE firms can have slightly different requirements in terms of returns and a preference in terms of risk appetite. The most seasoned PE firms are very transparent about their objectives and will keep referring to them consistently. That said, it is quite common for a PE firm to re-calibrate their expected return depending on progress or otherwise made in the first 12-24 months. If you deliver above expectation do not be surprised if your PE partner emboldens you to achieve more, or that it accelerates the anticipated exit time horizon. Any revision to the original plan should be collaborative.
5 Deal pricing
You want to be rewarded for your effort as an entrepreneur. The price that you are paid will be reflective of past performance, but just as importantly, how the business is positioned and how the opportunity set is outlined for the next period. Do not underestimate the importance of articulating the business plan and why you have the capability to execute on it. Some fantastic businesses do not get the premium price they deserve because the presentation of the opportunity is lacklustre. Equally, businesses which are “ok” can achieve premium results by being more organised and packaging it up for an investor better. I always encourage entrepreneurs to invest in sell-side advice and early preparation to increase your chances of success.
6 Relevant industry experience
Understandably there is an attraction to firms with experience in your specific industry. They will be able to speak the language on day one and be able to share a perspective on what happened in their previous investment. This is all valuable stuff. Things to look out for – is the person who did the previous deal/sat on the Board of the portfolio company still around, or did they move on? Has your industry dynamic moved on such that the strategy that worked in the previous situation is no longer as relevant? I would suggest that situational experience is as valuable as specific industry experience, if not more so in some cases. What do I mean by situational experience? A PE firm that has partnered with 25 healthcare services assisting companies facing similar challenges and at a particular stage in their business life-cycle could be a better partner than a firm that has completed 1 healthcare services deal in your particular healthcare niche. One of the powerful ways that PE adds value is by sharing best practice across its portfolio.
7 Working relationship rhythm
PE firms come in different flavours. Understand how PE firms like to partner and choose a style that suits your way of working. Some PE firms are very hands-off, some are supportive with in-house functional expertise that can support the entrepreneurial journey, and some sell themselves as being more day-to-day operationally involved. Make sure you know what you are getting yourself in for. You could get a rude shock otherwise. I’d personally question taking on a capital partner with an expectation of >20% IRR if they didn’t do anything other than provide the capital.
8 Personal alignment
You have successfully built your business from scratch or helped build a business to what it is today. You should discuss your personal ambition with your prospective equity partner. It may be unsettling if you say you want to leave immediately. PE firms typically back an incumbent management team and are looking to the CEO or Founder to own the plan – someone has to be ultimately accountable. Transparency is the key – PE firms don’t get phased by CEO/Founders looking for a change of role in the middle of an investment period, but they need to know in order to plan for well-executed succession.
PE typically plan for a 3-5 year investment period. The rule of thumb is that businesses that over-perform or are operating in a more favourable market environment can exit at the earlier end of that range. Situations that prove more difficult for whatever reason tend to extend out to 5 years or maybe even beyond. Some fund strategies could be more long term in thinking, PE firms are looking at longer term investment horizons more and more. Family Offices are likely to sell themselves as “longer-term capital”. Even where there is longer term time horizons, I believe its valuable to have periodic liquidity events to maintain interest levels from the management team through a dividend recapitalisation.
10 Funding capacity
Do your homework on the funding capacity of your potential PE partner. Does the firm have committed funds or are they doing what’s called “deal by deal syndication? It goes to funding risk if a firm does not have the committed funds or are relying on raising a material amount of external debt capital to complete a transaction. If they have enough to fund the deal but have no additional capacity for M&A and this is part of the growth story, this is a problem. A related topic is where does the PE fund sit in its fund lifecycle. If you are the last investment into a closed end fund, that may not be a problem per se, but it is good to understand how long is left in the fund and how much capital has been put aside for follow-on investment.